Gordhan's Budget Leaves Room for More South African Bond Gains

  • Time for under-performance to end, Rand Merchant Bank says
  • Morgan Stanley stays overweight as rate outlook improves

Forget the spike in yields after Finance Minister Pravin Gordhan’s budget presentation last week. South Africa’s debt rally has some way to go as government borrowing declines and rating companies hold off on downgrades, according to Rand Merchant Bank.

Yields on benchmark government securities due December 2026 climbed to two-week highs on Feb. 24 after Gordhan disappointed some investors, who fretted that he didn’t give enough detail on revenue plans and overestimated growth prospects. They should rather focus on Gordhan’s pledge to cut government borrowing to levels last seen in 2012, reduce the spending ceiling and curb the government wage bill, said John Cairns, a Johannesburg-based strategist at RMB, a unit of FirstRand Ltd., the second-biggest arranger of South African bond sales.

“The budget was much better than is being credited,” Cairns said by e-mail on Friday. “It’s time for the under-performance to end.”

South African government bonds have returned 3.8 percent for dollar investors this year, compared with an average loss of 0.3 percent for emerging-market local-currency debt, according to Bloomberg indexes. Even after jumping 16 basis points in the wake of Gordhan’s budget speech, yields on 10-year securities have declined 38 points since the beginning of January to 9.42 percent by 3:16 p.m. in Johannesburg on Monday. They may fall as low as 8.8 percent in the next three months, according to Morgan Stanley.

In his first budget after President Jacob Zuma reappointed him as finance minister, Gordhan said he will cut the budget shortfall to 2.4 percent of gross domestic product over the next three years, from 3.9 percent, reducing the amount the government has to borrow. Domestic bond sales will fall in each of the next three fiscal years, cutting supply of new debt to the market.

‘Much Tighter’

That may have averted the threat of a credit downgrade to junk for now. Standard & Poor’s, which has a negative outlook on South Africa and rates its debt BBB-, the lowest investment level, said the budget wouldn’t prompt an immediate rating action. S&P is reviewing its assessment in June.

The budget was “neutral or slightly positive” for South African bonds as it proposed “a much tighter fiscal consolidation plan” than expected, Morgan Stanley strategist Min Dai said in a note on Feb. 25. The U.S. lender is maintaining an overweight position in the nation’s securities, predicting a rally as expectations of rate increases dwindle and the risk premium narrows.

“We’ve demonstrated we’re not Brazil and that’s good enough to buy us some time,” Rashaad Tayob, a portfolio manager at Abax Investments, which oversees about $4.6 billion, said by phone from Cape Town, referring to the downgrade of the South American nation’s debt to junk. “We must wait for implementation now. If you just do a few things right, there’s a huge bucket of capital that can essentially come back.”

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